Millionaires may often talk in hushed tones about tax planning, as if they’re cheating the government by wanting to hold on to their hard-earned money. In reality, of course, the Internal Revenue Service (IRS) does not object to taxpayers leveraging legal tactics in their favor in an effort to minimize how much they pay in taxes, no matter what their net worth is.
If you’re a high net worth individual, a wealth manager from Pillar Wealth Management can help you understand and implement those legal methods for minimizing taxes. The company specializes in serving investors with $5 million to $500 million in liquid assets. And if your wealth exceeds $10 million, reading our comprehensive guide titled 7 Secrets to High Net Worth Investment Management, Estate, Tax, and Financial Planning should give you a tremendous start.
STRATEGIES FOR FAMILIES WORTH $5 MILLION TO $500 MILLION
The insights you’ll discover from our published book will help you integrate a variety of wealth management tools with financial planning, providing guidance for your future security alongside complex financial strategies, so your human and financial capital will both flourish.
Clients frequently share with us how the knowledge gained from this book helped provide them tremendous clarity, shattering industry-pitched ideologies, while offering insight and direction in making such important financial decisions.
Table of Contents
In this guide, we’ll focus on some tax-related insights based on advice from a high net worth tax advisor. Let’s begin with answering your query, “How can I reduce the amount of taxes I pay?”
How Can I Reduce the Amount of Taxes I Pay?
Here are some effective strategies for minimizing your taxes.
Choose Tax-Deferred Investment Vehicles
Qualified Retirement Plans
Among the easiest ways to defer investment income is to contribute to a qualified retirement plan such as a 401(k), 457, or 403(b) plan. Thanks to the SECURE Act, high-income earners who are 50 years old or older can make annual savings of around $27,000 via a 401(k), providing them with greater control over when to retire.
Until you make a withdrawal, your earnings stay immune to taxation. In other words, you won’t pay any tax on capital gains, dividends, and interest until you obtain a distribution from your account when you reach 59½ years of age.
You should also be interested to know that the IRS raised the contribution limits for 401(k) and 403(b) in 2022, allowing you to contribute a maximum of $20,500. For participants who are 50 years old or older, the catch-up contribution remains unchanged at $6,500. If you can’t maximize contributions due to cash flow issues, you may increase your contribution rate from 1 percent to 2 percent for the next year. Over the past year, if you did not rebalance your portfolio, it may have drifted away from its target allocation. Rebalance it now back to target, so that your portfolio is not subject to more or less tax than what you can afford. To learn more about tax-efficient retirement plans, schedule a video consultation meeting with our wealth managers today!
529 Plans for Education
Although you start out paying federal taxes on contributions, the contributed amount eventually becomes tax-free and so do any distributions for qualifying educational expenses. There’s no limit to the amount you can contribute in a year, but from 2022 onwards, anything you contribute above $16,000 per donor per beneficiary will go against the lifetime gift and estate tax exemption.
Manage the Timeline for Your Gains or Losses
The time at which you realize your gains or losses can make a huge difference in what you pay in taxes. This is why making simple adjustments to the timing can result in big tax savings. For instance, getting the time right for large gains can ensure that you aren’t pushed into the 20% capital gains bracket or become subject to the Medicare surtax. Here are some strategies to get the timing right.
When the stock market fails, sell out the loss-bearing investments in your taxable accounts, a tax-minimizing tactic called tax-loss harvesting. This way, you’re able to capture your losses on paper. For 2022, taxpayers are allowed by the IRS to deduct up to $3,000 in losses against regular income and offset losses with current-year capital gains and those of the next year. You may even carry forward the losses that you don’t use this year to the upcoming years.
Invest in QOF
The Qualified Opportunity Fund (QOF) was created in the Tax Cuts and Jobs Act. By investing in the fund within 180 days of the sale, you can defer the capital gains tax until 2026. By holding onto the investment for at least five years, you can make significant tax savings.
Contribute to a Charitable Remainder Trust
Charitable remainder trusts distribute funds to beneficiaries for a specified period. Anything that remains at the end of this period is donated to charity. When you contribute an appreciated, long-term asset, you not only avoid incurring tax on the gains but also receive a deduction based on the existing gift value.
Register as a Corporation
If you own and manage a business, you might be able to qualify for a deduction of 20% for qualified business income. Limited liability companies, S-corporations, and other pass-through entities are the only ones that can benefit from this break. Plus, if you’re single, your income must be below $157,500, while if you’re married and file jointly, your income must be below $315,000.
Incorporating your business also allows you to select the tax structure that works best for you financially. For instance, the tax rate for a C-corp is lower than that for sole trader or S-corp.
On top of that, not all professionals qualify for this deduction. If their income is too high, owners of service businesses and other entrepreneurs may not be able to benefit from this deduction. These can include financial advisors, doctors, attorneys, and so on.
If you don’t have a business but have a second home, rent it out and run it as a side business. You may benefit from certain tax deductions that you otherwise may not have. Having a separate physical location is not important. You can continue to run your business cost-effectively from home and yet be able to benefit from certain tax deductions.
Leverage Gift and Estate Deductions
Estate and gift deductions have been helping taxpayers lower their taxable income for a long time, but they’re even more desirable these days. If you’re fortunate enough to be a high net worth individual, consider giving monetary gifts to your loved ones. In 2022, you can gift up to $16,000 per individual to as many persons as you want without having to make IRS filings and pay gift tax. This minimizes your estate value while benefitting others. To dig deeper into how you can utilize estate and gift deductions, schedule a video consultation meeting with our wealth managers at your convenience.
Build a Tax Payment Strategy
In 2022, monitor your tax payments if you’re paying federal estimated taxes. This way, you should be able to exceed 100 percent of your 2021 tax liability or 90 percent of your 2022 estimated liability, so that you don’t end up facing underpayment penalties. Keep in mind that you need to make tax payments on a quarterly basis. Stay on top of dates when payments will be due. They include:
- First Quarterly Payment: April 18, 2022
- Second Quarterly Payment: June 15, 2022
- Third Quarterly Payment: September 15, 2022
- Fourth Quarterly Payment: January 16, 2023
Now that you know how to reduce the amount you pay in taxes, let’s address your next query: why do millionaires not pay taxes?
Why Do Millionaires Not Pay Taxes?
This is a common misconception that needs to be dispelled. Everyone must pay taxes, regardless of their income. It’s just that millionaires often make the most out of their inordinate resources to hire professional wealth managers, make tax-efficient investments, and donate to lawmakers to keep their tax burden low and grow their wealth unreservedly. If you wish to learn more about tax-efficient investments, our guide titled 5 Critical Shifts For Maximizing Portfolio Growth Strategies – For Families Worth $5 Million To $500 Million might be of great help.
Moreover, tax lobbyists working on behalf of millionaires facilitate and manage direct access between policymakers and the economic interests of the wealthy. Plus, the millionaires tend to hire tax lawyers who have an in-depth understand of the tax code. They’re aware of the loopholes through which they help their clients save as much money as possible when filing their tax return.
In addition, the wealthy, including millionaires, billionaires, and other high- and ultra-high net worth individuals, can shape laws because their voices are heard in government and at every step of the lawmaking process. Their teams of lobbyists, accountants, lawyers, and wealth managers study the regulations and legislation and help the wealthy take the IRS to court, if required.
As a high net worth individual, if you wish to minimize your tax burden like these rich people do, consider hiring a financial or tax advisor. Our guide Ultimate Guide to Choosing the Best Financial Advisor for Families worth $5 Million to $500 Million can help you find the right professional.
Now that the misconception has been addressed, let’s go on to solve another mystery: how do billionaires use loans to avoid taxes?
How Do Billionaires Use Loans to Avoid Taxes?
Borrowing money is among the key strategies America’s ultra-wealthy use to keep their tax bills low. They fund their lavish lifestyles by utilizing their enormous fortunes as collateral for loans that come with single-digit interest rates.
Obtaining loans enable the super-rich to avoid 37% of the federal tax on top incomes by earning minuscule salaries. It also enables them to bypass the top capital gains tax rate of 20% by avoiding selling stock to free up cash. Because loans don’t count as taxable income, the wealthy only need to pay back the interest and principal, and are able to avoid the higher taxes on their billion-dollar investments and incomes.
For example, Forbes revealed that the five wealthiest Americans increased their net worth by $401 billion between 2014 and 2018. Yet, the amount they paid in federal income tax during that period was only $13.6 billion, that is, only 3.4% of their combined wealth. One the other hand, between 2014 and 2018, a middleclass American individual in their 40s experienced an increase of $65,000 in their net worth, but their income taxes amounted to $6,200. That’s almost 9% of their new wealth.
Let’s consider popular figures. Elon Musk, for example, has put up an enormous amount of his equity in SpaceX and Tesla as collateral for loans, instead of selling shares and freeing up the money by paying 20% in capital gains tax.
Besides using loans, billionaires also closely monitor the performance of their investments and align them with their tax minimizing strategy. If you want to follow in their footsteps, study our Performance Guide.
After going through this guide, you should have not only developed an extensive pool of tax-minimizing strategies but also obtained a fair idea of what the super-rich do to minimize their tax burden. With the complexities associated with taxation in mind, if you decide to hire a financial advisor, look nowhere else. Pillar Wealth Management, which serves investors with $5 million to $500 million in liquid assets, is here to do the heavy lifting for you! To hire a financial advisor, conduct a video consultation meeting today!
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